Asset Primer I: Stocks

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Hopefully you have started your financial path to, and possibly have already achieved, becoming a Capitalist.

Regardless of where you are in this journey at some point you will have a certain amount of money “sitting on the sidelines” and ready to be deployed as your untiring worker.

One of the scariest decisions is to take that hard-earned, and even harder to save, money and send it out in the world in hopes that not only will it return back to you but also bring more of its friends along in the process.

With so many investing opportunities out there an investor can be overwhelmed and easily suffer what is called analysis paralysis.

In essence a potential investor is paralyzed by indecision due to the fact that there are so many opportunities out there.

“Twenty years from now you will be more disappointed by the things that you didn’t do than by the ones you did do.” -Mark Twain

In order to make the investing world more manageable it is crucial to break it down into more manageable components, called asset classes.

The big three asset classes are Stocks, Bonds, and Real Estate, each with it’s own pros and cons for a potential investor.

I feel a primer is therefore necessary to give you a very basic overall lay of the land.

Stocks:

Buying stocks is in essence buying a share/equity stake in a company or companies.

Pros: Over longer timeframes has resulted in greater returns than bonds

Cons: More volatile than bonds/real estate.

There are many ways to categorize stocks:

Geographic location

Domestic (US based)

International

Developed

More economically advanced/stable countries (which can include such countries as Canada, Germany, the U.K., Australia, New Zealand and Japan)

Emerging

Countries which are rapidly developing but do not have stable mature capital markets and have typically lower per capita income levels (Brazil, Russia, India, and China, Portugal, Ireland, Italy, Greece, Spain can fall in this category)

Market capitalization

Large cap (>$10 billion) and Mega cap (>$200 billion)

Tend to be more stable/less volatile or risky

Mid cap ($2-$10 billion)

Considered less risky than small cap stocks, more risky than large cap stocks.

More growth potential than large cap stocks

Small cap (<$2 billion)

Riskier/more volatile than mid and large cap stocks

Can outperform large cap stocks when emerging from a recession but typically underperform during recession

Have an even riskier subset of micro-cap ($50 million-$2 billion) and nano-cap (<$50 million)

Market Sectors

Stocks can be classified into sectors by the types of companies they represent

WARNING: Beware of mutual funds that give commissions to the salesperson selling them (these are referred to as front loads) which can typically cost 5% of your initial investing amount.

Can raise questions if the financial advisor has ulterior motive putting you into these funds versus lower cost ones

As previously mentioned there are so many options available to an investor that it seems daunting.

In any given time period there can be winners and there can be losers.

It would be great if we can know beforehand which horses to bet on but this is not the case.

Sectors come into and then fall out of favor throughout history.

(https://gimlink.com/guardian-sector/)

So what is an investor to do?

I feel one of the best ways to have your portfolio exposed to stocks is by investing in the entire market passively.

In 1976 Jack Bogle, gave a gift to the individual investor by creating a Vanguard index fund, the Vanguard 500.

By purchasing this one mutual fund with far lower expense ratios than the more common (at the time) actively managed funds, an investor had an equity share of the top 500 US companies.

Today in addition to this original fund, Vanguard (and many other companies) have created total index funds (for Vanguard it is VTI) which essentially allows to invest in every company in the stock market based on their market capitalization.

For the US domestic stock component of my portfolio the Vanguard Total Index fund is a major component.

Similarly there are total international stock index funds such as Vanguard Total International Stock Index Fund (VGTSX) that offer the same benefit but in an international arena.

With a total index fund as my core, I do not have to worry on which sectors will be winners (or losers) that year, for I will have exposure to them all and in the end it will balance out.

As the following chart clearly demonstrates, the trajectory of the stock market long term is always upwards.

(www.marketwatch.com)

One does not have to be greedy and try to beat the market.

If an investor is patient and stays the course, great wealth can be achieved by just following the market.

This passive total index approach to stock investment has been endorsed by what most consider the greatest active investor of our time, the wizard of Omaha, Warren Buffet, who won a million dollar bet backing index passive investing against active investing.

In fact in a 2014 letter to his shareholders of Berkshire Hathaway, Warren Buffet detailed plans of leaving cash to a trust for his wife’s benefit with instructions to place 90% in index funds and 10% in bonds.

Unless you are the next Warren Buffet, I suggest you follow a similar course.

A passive total index mutual fund is also a primary component in one of the more popular and simpler portfolio allocations, the Boglehead’s 3 fund portfolio.

Superpower Take-home Points:

Don’t suffer analysis paralysis and take no action towards investing in the face of overwhelming choices

Eliminate the desire to try and beat the market. Instead create wealth by following/indexing the market which has always shown an upward trajectory

Beware of fees, hidden or otherwise and potential motives of those selling particular funds (commission based front-loaded funds)

Rather than try and pick individual stocks that carry high risk, diversify with mutual funds and follow Warren Buffet’s advice of passive indexing

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NOTE: The website XRAYVSN contains affiliate links and thus receives compensation whenever a purchase through these links is made (at no further cost to you). Although these proceeds help keep this site going they do not have any bearing on the reviews of any products I endorse which are from my own honest experiences. Thank you- XRAYVSN

Beautifully explained! Investing in stocks is a great way to earn passive income but you need to know where you are investing and why. I totally agree with you that most people are better off investing in an index fund or ETF that matches the S&P 500 which will provide great diversification and pretty good returns. The most important part as you said is avoid those Fees!! People need to recognize that just a 1% increase in fees can eat away your returns dramatically.

I really appreciate the comment (and thanks for stopping by!). Yeah the fees are quite deceptive. Most people think well 1% is really nothing, but if you think about it, that 1% was taken out of the investing pool so it doesn’t have a chance to grow with the market and get dividends and then compound. It can easily be a 6 figure savings over a normal 20-30 year course of investing.

Great primer Xrayvsn. This is the sort of basic knowledge everyone needs to take control of their finances.

I feel like many times those of us who enjoy finance forget how overwhelming it can be for beginners. This is exactly the type of post that can be super helpful to those who are just starting to get their feet wet.
-Ray

Really appreciate the kind words Ray. The next few posts are part of my investing basics series. Nothing earth shattering about them but I wanted a collection so that viewers could at least have a convenient place to look at them all.

Great introduction to the various asset classes. I like the sectors chart you put up. It reminds me of a game (maybe BINGO?). LOL. Anyways, it demonstrates that sectors are cyclical and that it is important to be diversified among the various sectors in addition to the different asset classes.

Thanks Dr McFrugal. Yeah sectors always have a certain cyclical path. To be honest I have played around with some just with side money, wheneve a sector gets depressed I put some money into it if I can and lo and behold eventually it becomes a sector leader (I did that with energy and real estate). I was going to do it with financial (they were really down a year a so ago and wish I did because that had the upswing recently). I’m sure you can take advantage of these sector cycles (buy more of those in the doghouse… Read more »

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1 year ago

Guest

Gasem

Bogel suggests a bond fund and S&P500 fund. Buffets suggests the same for his wife. Nothing about international or real estate. Nothing about total stock market. I would add re-balancing every couple years which further reduces risk. Think these guys might be onto something?

I agree, can do very well just with stocks/bonds like some of the biggest names in the finance industry speak of (although I thought I heard recently Bogle had suggested putting some international in a portfolio).

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1 year ago

Guest

Volunteer Pediatrician

Excellent primer on stocks. As a young physician, I always wanted to own the hot stock. Now looking back, I should have just put my money in the total stock market index. I would have made a better return with a lot less hassle.

Thanks for stopping by and leaving a comment. I was like you and spent way too much time buying and selling individual stocks at $7/pop on Scottrade. I actually got lucky sometimes without knowing anything about it at all. Just picking names I recognized. Fortunateiy came across concept of index investing which made perfect sense and that is the way I invest now.

Don’t over analyze, jump in now… you will thank yourself so much later. As most of us in the community, i’m obviously partial to the stock market, but coming from only investing in index funds…. i’m more open now to exploring single stock investments as a small percentage of assets.

Hey 1/2 Life. Appreciate the comment. I do have 1 individual stock I hold on to (Tesla (which is not for the faint of heart if you don’t like volatility, lol). I bought it when I bought my car because I really believe in the product and what they are trying to accomplish. Hopefully I look like a genius decades from now 🙂